Remarks by the Director of the Bank of Israel Research Department, Prof. Nathan Sussman, at the press conference marking the publication of the Bank of Israel Annual Report

As
the Governor showed, the state of the economy is good and growth is solid. In order to complete the picture presented by
the Governor, I will detail some of the macroeconomic analyses presented in the
report this year. I will then relate to
a few other issues from among the wide variety of issues covered in the report
this year.

The
relatively rapid growth this year was led, as in recent years, by private consumption. However, we saw positive developments in
exports and investments this year as well, which were connected to similar
changes in the global economy, and these may portend to a gradual emergence
from the long financial and economic low in which the global economy has been
since 2008.

The
faster growth of the Israeli economy in the past year, compared with growth in
the OECD, is a result of the faster growth of private consumption thanks to the
financial strength of the economy, the support of accommodative monetary and
fiscal policy, and in the past year or two, the decline in relative prices,
which I will discuss later. In contrast,
the economy dealt with slower growth of exports, which was affected by the appreciation
of the shekel.

Exports
performed more weakly than in other advanced economies, mainly as a result of
goods exports that are more sensitive to appreciation, since they are exposed
to stronger competition in international markets. Israel’s services exports—mainly high-tech
services, in which Israel has a relative advantage—enjoyed greater market
strength, and therefore increased at a higher rate than other advanced
economies, despite the appreciation.

Some
of the appreciation we have seen in recent years is a result of the current account
surplus—the gap between exports and imports—in Israel’s balance of
payments. As such, it is considered as
deriving from positive basic forces in the Israeli economy. In the Annual Report this year, we examined
the development of the current account from a different point of view—by
looking at the surplus of savings over investment in the Israeli economy. We found that while the rate of savings in
the Israeli economy is similar to that in other advanced economies, the rate of
investment is lower, to the point that it does not make it possible to close
the gap in the standard of living between Israel and the wealthiest
countries. In particular, we found that
the rate of government investment in infrastructure and buildings is low,
partly as a result—as the Governor showed earlier—of the desire to limit public
expenditure in the economy and of the fact that the government dealt with the
budgetary crisis it faced in recent years through cuts that negatively impacted
infrastructure investments. Thus, a
problem of a short-term character became a long-term problem.

As
such, the basic surplus in the current account is partly the result of policy
that acted to shrink the size of government in the economy—a policy that
resulted in, among other things, reducing investment in infrastructure, leading
to a negative impact on productivity and long-term growth potential. Indirectly, since the current account surplus
was not a result of high productivity and growth, it led to appreciation and a
negative impact on exports—a high productivity growth engine.

One
of the phenomena that has been of particular benefit to the Israeli economy in
recent years has been the improvement in its terms of trade, which is mainly a
result of the decline in the prices of products that Israel imports, but is
also a result of the increase in prices of the products that it exports. We can saw that the economy’s profitability
increased—it is purchasing at low prices and selling at high prices. This positive development leads to two results:
First, the economy’s income increases and consumers can consume more. Second, the prices of some consumer goods
decline, so that workers enjoy an increase in their real income, while firms
are not required to increase their wages.
This maintains firms’ profitability even in a tight labor market with
low unemployment. However, this
phenomenon is generally temporary. Some
of the decline in import prices is also a result of the appreciation, which is
obviously beneficial for consumers in the short term, but may impair imports
and growth in the long term.

One
of the issues that is also connected with the developments in the terms of
trade is the relatively moderate rate of increase in nominal wages. In the chapter dealing with labor market
issues, we examined this phenomenon, the main explanation for which is the
slightly higher level of inflation. In
recent years, we have seen that total wages as a share of GDP is stable—and
even increasing—such that there is no erosion in workers’ income relative to
GDP. This follows some decline in
workers’ share of GDP, a decline which was more significant in 2002–3 and in
2009. We cannot explain this significant
decline through factors that explain the development of wages over time—such as
productivity, inflation expectations and the unemployment rate. The analysis shows that workers’ share of GDP
eroded during the economic crisis, when workers agreed to reduced salary in
exchange for job security. Another
explanation for the relative erosion of workers’ income as a share of GDP is
derived from reduced taxes on employment, chiefly income tax—which makes it
possible to increase workers’ net income in Israel relative to their peers in
the OECD without increasing gross wages or wages as a share of GDP.

Support
for private consumption as a growth engine has come in recent years from both
the strong labor market and the increasing access to credit. The banking system in Israel expanded in
recent years, mainly in the areas of credit to households—housing and nonhousing
credit—and has increased at an even higher rate in the past two years. However, the expansion of credit was
congruent with the increase in income, such that the credit taken by households
relative to GDP remained stable and low compared to reference countries.

In
view of the low interest rates, the question arises regarding the proper mix of
assets to be held in the pension savings portfolio. From the standpoint of the pension saver, the
farther the investment horizon, the more desirable it is to invest in more risk
assets that generate a higher yield. The
average investment portfolio of the Israeli pension funds is more conservative
by international comparison, and the percentage of shares and other assets with
a higher risk is low. In parallel, exposure
to foreign markets is also relatively small.
Due to the size of the stock market in Israel relative to the volume of
pension savings, increasing the rate of investment in shares involves an
increase in the rate of investment abroad.
The incentives for investment managers—short-term comparisons of yields
and the possibility of moving savings, which are intended to increase
competition between the entities managing pension money—may have created a
preference for achieving yields in the short term, a strategy that is not
beneficial for long-term savers.

The
government is acting to increase the supply of dwellings in order to lower
their prices, by increasing the number of planned homes, permits and
marketing. Contractors’ have been able
to follow suit due to an increase in labor inputs by foreign workers, which
provides some response to the short-term problem, but involves low productivity
in the industry and delays its long-term technological development.

The
“Buyer’s Price” program put in place this year acted to lower home prices for
lottery winners. The largest declines in
prices relative to prices in the open market were in localities where demand
for housing is high, so that land is a larger part of the dwelling price in
those localities. The benefit was made
possible due to a discount on the land and competition between developers in
those localities.

This
year, we chose to focus the chapter on welfare issues on the issue of internal
migration—between localities in Israel—of population groups characterized by
high poverty rates and low employment.
We found that in the new ultra-Orthodox cities, the employment rates of
ultra-Orthodox men are low, and migration to these cities is not for employment
considerations, but an attempt to cope with housing costs. It is therefore very important to create work
places in these cities, as well as an efficient public transport system to
employment centers, and to carefully consider the benefit of establishing
additional cities of this type, particularly if they are distant from
employment centers.

In
contrast, we found that the rate of employment among Arab women living in
Jewish cities is significantly higher than that of Arab women living in Arab or
mixed urban areas. Their migration to
such localities is apparently motivated by employment considerations and allows
their integration into the labor market. However, migration is very low, and it
is therefore important to invest additional public resources in strengthening the
Arab localities and their residents.

In
summation, we can see that the tradeoff between the attempt to achieve
short-term results and the results expected in the longer term is a common
thread in many of the issues on the policy agenda that are dealt with in the
report. These include, for instance, the use of lower public investment as a
means to reduce short-term public expenditure vs the long-term implications for
public infrastructure and growth; increasing short-term yields in the pension
savings portfolio vs. the long-term yield that is of real importance in such
savings; increasing the number of non-Israeli workers in the construction
industry in order to increase its short-term production capacity vs. the
long-term negative impact on productivity in the industry and the wages of its
workers; and establishing new ultra-Orthodox cities as a relatively quick
solution to the housing shortage in the sector vs. the difficulty in providing
quality jobs in these cities over time.

Increasing
the prominence of long-term considerations will contribute to increased growth
and the long-term well-being of Israel’s citizens.​